Reserves, quotas and the demand for international liquidity

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Publication

The foreign exchange reserves held by emerging market economies rose significantly in the last decade. This increase has been attributed to a desire by these countries to self-insure themselves against financial shocks. The rise in reserves may also reflect their concerns about the size of their IMF quotas, which set limits on the amount of credit that countries could draw from the IMF, and the conditionality associated with borrowing from the IMF. We offer a model of the choice by central banks between quotas and reserves to demonstrate that emerging markets will choose to hold relatively more reserves than advanced economies. We then investigate the impact of IMF quotas on reserve holdings for a panel of countries during the period of 1980-2006. In addition to finding evidence of precautionary and mercantilist motives for holding reserves in emerging markets, we also find that reserves in these countries have been inversely related to their IMF quotas.